Yahoo Finance Is ARRIS International plc (NASDAQ:ARRS) Attractive At This PE Ratio?
I am writing today to help inform people who are new to the stock market and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
ARRIS International plc (NASDAQ:ARRS) is currently trading at a trailing P/E of 39, which is higher than the industry average of 29.9. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio.
See our latest analysis for ARRIS International
Breaking down the P/E ratio
The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for ARRS
Price-Earnings Ratio = Price per share ÷ Earnings per share
ARRS Price-Earnings Ratio = $25.91 ÷ $0.664 = 39x
On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to ARRS, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. At 39, ARRS’s P/E is higher than its industry peers (29.9). This implies that investors are overvaluing each dollar of ARRS’s earnings. This multiple is a median of profitable companies of 25 Communications companies in US including GuanHua, Inventergy Global and Ciena. You could think of it like this: the market is pricing ARRS as if it is a stronger company than the average of its industry group.
Assumptions to watch out for
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to ARRS. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where ARRIS International plc is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. Of course, it is possible that the stocks we are comparing with ARRS are not fairly valued. Just because it is trading on a higher P/E ratio than its peers does not mean it must be overvalued. After all, the peer group could be undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to ARRS. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for ARRS’s future growth? Take a look at our free research report of analyst consensus for ARRS’s outlook.
Past Track Record: Has ARRS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of ARRS’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
